Earlier this month, I had the opportunity to discuss Latin America’s regional outlook with government leaders, parliamentarians, and university students in Brazil, Panama, and Uruguay.

The key conclusion that I took away from these meetings is that Latin America facestwo principal economic challenges: to increase the sustainable rate of economic growth and to reduce the volatility of growth.

In my meeting in Calgary on March 26 with Finance Ministers of the region, I focused on the second challenge so that favorable conditions today do not come at the expense of a bust tomorrow.

It’s a nice coincidence that this meeting of Finance Ministers of the Americas and the Caribbean was held here in Calgary. Canada is a good example of “managing the good times,” but as in many countries across the globe, some challenges remain.

Managing the good times

Turning to Latin America, here are three ways in which the region can reduce its vulnerability to wide economic fluctuations.

First, sound economic policies. One of the reasons the region weathered the global financial crisis relatively well is that it had made significant gains in improving economic fundamentals in the years leading up the crisis. This included reducing inflation and public debt, improving the composition of debt, strengthening fiscal institutions, introducing greater exchange rate flexibility and credible monetary regimes, and building up foreign reserves. This progress should continue.

Second, financial stability. As the region becomes increasingly integrated in the global economy, it will also become more exposed to the volatility of capital flows. At the same time, financial deepening, though welcome, can bring its own challenges, for example, the risk of credit bubbles. This calls for continued efforts to strengthen the financial system. In particular, regulators and supervisors should be empowered to take early preventive action—including using macroprudential tools.

Third, a more diversified economy. There is no simple recipe for achieving the diversification needed to reduce vulnerability to specific external shocks. But countries should continue efforts to foster new sources of growth. More public funding for infrastructure and human capital development can help. Improvements in the business climate—which in some countries includes security—and overall governance are also essential to attract private investment.

What does all this mean now?

Growth in most Latin American economies is now back at potential, or above—and in many of them there are worrisome signs of overheating.

Clearly, the earlier economic stimulus needs to be reversed. Furthermore, a range of policies could be used to prevent overheating and dampen the credit cycle, including upward exchange rate flexibility, a more appropriate mix of monetary and fiscal policies, and adequate financial regulations—including a macroprudential approach. In some cases, capital controls might also be useful. But they should not substitute for fundamental policy adjustments.

Finally, I also talked about sharing the benefits of growth more broadly.

While the region has enjoyed tremendous social gains, poverty and income inequality remain high in Latin America compared with other regions. To have more equitable growth, efforts should center on strengthening the provision and quality of education, health, and public infrastructure. This includes better targeting of government spending and strengthening social safety nets.